REITs offer straightforward exposure to otherwise hard-to-access real estate assets and historically strong performance with low levels of correlation with equities returns. Yet, we believe they’re chronically underutilised in most portfolio allocations, and especially in retirement portfolios.
Over the past decade, up until the COVID-19 pandemic Australian REITs had made significant progress in reinforcing their established value proposition as a more defensive asset class, offering comparatively lower levels of volatility and greater consistency of income than equities1. In general, we believe this has been achieved as the market has had lower appetite for risk and leverage for real estate since the global financial crisis and most companies have more diversified capital sources and better management of that capital than in the past.
Yet misconceptions still persist, especially in light of the pandemic drawdown - here’s three reasons why we believe they’re wrong over the longer term:
Myth: AREITs aren’t real estate
According to this argument, the short-term volatility of REIT prices is so far removed from asset values in the property sector that they shouldn’t really be considered property at all. Over the longer term, however, research shows that returns in the bricks and mortar assets held by REITs feed their way into share price performance2.
Some market participants seem to think that because REITs are a liquid version of real estate they should churn to realise their value, but to properly access the linkage between returns and underlying asset values, we believe investors need to be able to commit to timeframes that outlast this short-term volatility. In general terms, and in our view, that means allocating capital on a minimum five-year horizon, as you would if you were buying the underlying real estate directly (the one without liquidity). The liquidity is therefore there, should you need it.
Myth: AREITs lack opportunities to capture growth
Perceptions of the Australian property sector centre around traditional stalwarts such as office and retail, and in particular large shopping centres. But AREITs actually offer a range of opportunities outside traditional real estate which are well-diversified by company, cyclical exposure and by sector, including industrial (which currently makes up the largest part of the benchmark), health care, aged care, childcare, manufactured housing, self-storage and data centres. This list is growing, and in our opinion should continue to increasingly replicate the diversity of the US market in time.
You might recognise a number of sectors in that list which are exposed to strong upside from global structural megatrends, such as digitalising of the economy or demographic shifts such as aging populations, and in reality you can find an expression for most meaningful trends within the AREIT asset class.
In our opinion, it’s considerably harder to find the same diversity in local unlisted real estate, where these opportunities don’t yet exist at scale and major diversified vehicles are still steeped in the traditional three food groups of retail, office and industrial (but with a low allocation to this last sector). As these alternative real estate classes evolve it will take some time for institutional fund managers to recalibrate their portfolios in search of a better risk/return proposition and lower volatility of underlying cash flows that these alternative sectors can offer.
In contrast, the listed market is relatively dynamic and often leads the unlisted market by several years.
Myth: asset quality is lower in listed property
In our view, the truth is quite the opposite. Australia is the most highly-securitised real-estate market in the world3, and that penetration starts with the highest quality assets and works backwards. In any CBD around the country you can look out the window and be certain that most of the buildings you see are owned by listed entities and accessible for investment five days per week via the stock exchange.
Because the highest-quality assets are found in listed property, we believe REITs can attract some of the best real-estate talent in the market, helping to build out the best portfolios, in turn attractive to capital which creates a self-fulfilling cycle and one borne out by return profiles.
The transparency and accountability of listed entities also upholds quality in AREITs. There is a large amount of publicly available information on portfolio composition and performance, and the ratio of brokers to market capitalisation is higher in Australia than in overseas markets. Reporting takes place on a day-to-day basis rather than quarter-by-quarter or six monthly (as is the case in unlisted). Management teams who allocate capital poorly, or who buy or develop assets that detract value or deviate from the REIT’s objectives, ultimately have a higher cost of capital and struggle to grow. The end result is quite Darwinian, culminating in shareholder unrest and either a change of management or acquisition by another fund whom have the management able to derive superior returns from those same assets. Just like any other equity, there is nowhere to hide when your real estate portfolio is listed for all to scrutinise, which we think is very healthy long term to achieve optimal asset returns.
We’re currently at an inflection point, with huge structural adjustment underway in property markets at home and overseas as the old guard makes way for the future. Institutional acceptance of alternative assets will happen in time as the security of the underlying cashflows are assessed and understood. In the meantime, we believe these opportunities will be created by disparities between changing needs and existing property stock.
In this context, and in our view, investors can’t afford to harbour these kinds of misconceptions about AREITs, which will be valuable tools to capture value from unfolding changes to the ways in which society values space.
1. AMP Capital
2. Green Street Advisors (2018), If it looks like a duck
3. UBS Analyser
Subscribe below to Institutional Edition to receive my latest articlesJames Maydew, Head of Global Listed Real Estate
1 MSCI U.S. REIT Index, AMP Capital
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